UK banks pounce on ECB loans

BRITISH banks joined the queue for hundreds of billions in cheap three-year loans from the European Central Bank as its funding lifeline for the region's financial institutions surged past the AU$1 trillion mark.

The ECB's second burst of three-year loans under its so-called long-term repo operation (LTRO) drew bids from 800 banks for a total of AU$529.5 billion. The higher-than-expected amount takes the total to $1.02 trillion after the ECB lent $489 billion to 523 banks under its first LTRO last December.

Lloyds Banking Group drew down $13.5 billion in ECB loans, putting it among the biggest users, while HSBC borrowed another $350 million following the $5.2 billion it took in December. Barclays and Royal Bank of Scotland refused to comment on their participation.

Mario Draghi, the president of the ECB, sanctioned the move to flood the financial markets with cheap cash last year to avert a credit crunch and bank runs in weaker eurozone states as the sovereign debt crisis intensified. The initiative has helped to trigger a rally in stock markets, while Spain and Italy have seen their borrowing costs fall as banks pump the three-year loans - charged at knockdown rate of 1 per cent - into previously spurned sovereign debt offering higher returns.

Yesterday's auction further eased the market pressure on Italy, which saw benchmark 10-year bond yields fall to 5.18 per cent, their lowest since last summer, after spiking at a unsustainable 7.52 per cent last November. Spain's borrowing costs also slipped below 5 per cent yesterday.In evidence to the Treasury Select Committee, Sir Mervyn King, the Governor of the Bank of England, said the loans had staved off a banking collapse in the eurozone's southern states.

He said: "The prospect of a bank run in the eurozone area has been removed by the action of the ECB."

Martin van Vliet, an analyst at ING Bank, said: "The higher number of participating banks might also reflect fresh demand from banks that did not participate in December because of reputational considerations, but concluded that it was an offer they couldn't refuse after all. In any case, we expect Italian and Spanish banks to have remained the heaviest users of the facility, as in December they took up almost half of the total."

Bank shares rallied across Europe as analysts said the auction had delivered a "Goldilocks" result, with the handouts not large enough to spark fears over Europe's banks, but high enough to help banks to pay off a big chunk of bank debts falling due this year.

But Nick Matthews, an economist at Royal Bank of Scotland, warned of the dangers of banks' dependence on funds from the ECB, which is likely to expand the size of its balance sheet to $3 trillion through the move.

He said the move helped banks stave off risks in the near term, but "LTROs do not address the underlying solvency issues and ultimately funding stresses can quickly return. Given that there are no further tenders scheduled and the recent ECB rhetoric has been skewed towards this being the last, we believe the market will return to fundamentals and move away from this liquidity euphoria."

Paul Tucker, a deputy governor of the Bank of England, warned that UK banks were feeling the effects of the financial chaos in the eurozone despite the ECB's action.

He told MPs: "The tangible possibility of calamity in the euro area increases bank funding costs, even though UK banks have gone some way to strengthening their balance sheets."